Effective management of working capital can enable companies to free cash from their balance sheet and put it to more productive use in growing their business.
With demand for commercial paper down dramatically, many CP issuers have responded in predictable fashion by tapping bank lines of credit, or, in more extreme cases, by issuing long-term debt. While such responses make sense for companies facing an urgent cash crunch, it is important to recognize their potential danger as long-term solutions to corporate funding problems.
Under the pressure of increased demand, the cost of bank credit is already starting to rise, suggesting that, over time, it may not remain the reliably cheap source of capital it has been in the past. And using long-term debt to fund short-term obligations is a classic financing problem, as well as a significant consideration for analysts as they watch how companies manage their long-term debt.
The question, of course, is what to do as an alternative. For many companies, the answer can be found on their own balance sheet. By optimizing working capital management practices -- that is, by more efficiently executing the policies and processes that impact working capital in the C2C (customer to cash), P2P (purchase to pay) and F2F (forecast to fulfill) cycles. Where appropriate, cash freed from working capital can also be used to pay down debt, buy back stock or even increase the company's dividend.
While working capital improvements won't generate cash as quickly as tapping a line of credit, companies can unlock dramatic amounts of money from their operations in surprisingly short periods of time -- with no obligation to pay it back.
A few years ago, for example, an integrated building-products manufacturer implemented a fast-track working capital optimization program that freed more than $200 million from working capital in just four months. The initiative focused on improving the company's C2C and P2P processes, which had been inconsistent among its various business units. The company also had been suffering from a near complete absence of expenditure controls, which, in some cases, had been causing it to pay suppliers ahead of terms.
To stop the bleeding, the company standardized and rationalized its customer and supplier terms, rewrote its payment and collection policies to better manage risk, linked its procurement and accounts payable processes, upgraded its systems to reflect these new policies, then instituted a measurement system that allowed management to monitor and help control cash flow. The $200 million recovered through these initiatives...